Required:(1) Determine whether Grealish will accept the contract. Show calculations of his utility to two decimal places. Also, indicate whether Grealish will work hard or shirk. (include all steps of calculation)(2) Calculate Jack's utility. Jack is risk-neutral and his utility for money is equal to the cash received. (include all steps of calculation)(3)Jack's business has publicly traded shares. Explain whether you would recommend a compensation contract based on both net income and share price performance under the following conditions;a- Net income is calculated based on historical cost.b- Net income is calculated based on fair value accounting. Jack, the sole owner/manager of a small business is interviewing Grealish for theposition of manager while he pursues other interests. Jack knows from herexperience that if the manager works hard, the company will earn cash flows of$1,000 with a probability of 0.8 and earn cash flows of $700 with a probability of0.2. If the manager shirks, the cash flows are $1,000 with a probability of 0.2 and$700 with a probability of 0.8.However, cash flows will not be known until the end of two years, and Jack decidesto base managerial compensation on net income according to GAAP. He knows thatwhen cash flows are $1,000, then net income will be $1,200 with a probability of 0.7and $450 with a probability of 0.3. However, when cash flows are $700, net incomewill be $1,200 with a probability of 0.3 and $450 with a probability of 0.7.Net income is before the manager's compensation. Grealish has a square root utilityfor money received and his reservation utility is 2.6. If Grealish works hard, hisdisutility of effort is 8 and if he shirks, his disutility of effort is 7. Jack offers Grealish16% of net income as compensation.

Utility is like a happiness score for people when they make decisions. Imagine you're picking…

Answered: Required: (1) Determine whether…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Required:

(1) Determine whether Grealish will accept the contract. Show calculations of his utility to two decimal places. Also, indicate whether Grealish will work hard or shirk. (include all steps of calculation)

(2) Calculate Jack's utility. Jack is risk-neutral and his utility for money is equal to the cash received.

(include all steps of calculation)

(3)Jack's business has publicly traded shares. Explain whether you would recommend a compensation contract based on both net income and share price performance under the following conditions;

a- Net income is calculated based on historical cost.

b- Net income is calculated based on fair value accounting.

Jack, the sole owner/manager of a small business is interviewing Grealish for the
position of manager while he pursues other interests. Jack knows from her
experience that if the manager works hard, the company will earn cash flows of
$1,000 with a probability of 0.8 and earn cash flows of $700 with a probability of
0.2. If the manager shirks, the cash flows are $1,000 with a probability of 0.2 and
$700 with a probability of 0.8.
However, cash flows will not be known until the end of two years, and Jack decides
to base managerial compensation on net income according to GAAP. He knows that
when cash flows are $1,000, then net income will be $1,200 with a probability of 0.7
and $450 with a probability of 0.3. However, when cash flows are $700, net income
will be $1,200 with a probability of 0.3 and $450 with a probability of 0.7.
Net income is before the manager's compensation. Grealish has a square root utility
for money received and his reservation utility is 2.6. If Grealish works hard, his
disutility of effort is 8 and if he shirks, his disutility of effort is 7. Jack offers Grealish
16% of net income as compensation.

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